Real Estate Projects as Catalysts for Performance and Sustainability
The real estate asset class grapples with challenges in a market marked by elevated interest rates. Effectively navigating this landscape is crucial for funds aiming to secure additional income for investors, but inherent risks loom overhead.
(Author: Philip Hinsen, Head Legal & Compliance at Solutions & Funds)
In the aftermath of interest rate hikes, the Swiss real estate landscape has shifted, impacting investors in real estate funds. At the same time, construction activity in Switzerland has waned in recent years, and building permits hit a record low.
Real estate funds, faced with increased financing costs and heightened allure of alternative assets, must focus on generating sustainable long-term returns for their investors.
Advantages of Real Estate Development Over Existing Properties
Real estate projects incorporated into investment strategies offer dual benefits over existing properties:
- Real estate development projects provide investors with essential additional income. Investing early in construction projects significantly enhances return opportunities compared to existing properties. The main advantage lies in the potential increase in value resulting from project development.
- Real estate projects, new construction projects in particular, offer quicker and more efficient improvements in a portfolio’s sustainability metrics due to their focus on key criteria such as sustainability and energy efficiency.
Despite these advantages, real estate development brings with it specific risks, such as development, valuation, and loss of earnings risks. It is crucial to also consider liquidity risk as this may hinder the fund’s ability to fulfil its obligations pertaining to, for example, construction and/or renovation projects or meeting investors’ requests to redeem their fund shares.
Investments in Building Plots Must Meet Strict Requirements
Swiss real estate funds can primarily invest in various property types, including residential buildings, commercial properties, mixed-use buildings, co-ownerships/condominiums, and leasehold properties, as well as building plots (including demolition properties) and constructions in progress. However, new constructions are only allowed if expressly stated in the fund documents.
To manage risk, real estate funds must adhere to diversification rules, distributing properties based on use, age, structure, and location. Specific criteria govern undeveloped plots:
- The plot must be readied for building and suitable for immediate development.
- A legally binding building permit must be in place at the time of acquisition.
- Construction work should begin before the building permit expires.
In conclusion, building plots are a permissible asset for a real estate fund only if a corresponding building permit is in place at the time of acquisition. It is important to note that the allocation to building plots, including demolition properties and construction in progress, must not exceed 30% of the fund assets due to associated risks. However, real estate funds for qualified investors enjoy more flexibility, as FINMA can exempt them from certain regulations, either fully or partially.